DP10428 GLM estimation of trade gravity models with fixed effects

Author(s): Peter Egger, Kevin E Staub
Publication Date: February 2015
Keyword(s): fixed effects, generalized linear models, gravity models
JEL(s): C23, F14
Programme Areas: International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=10428

Many empirical gravity models are now based on generalized linear models (GLM), of which the Poisson pseudo-maximum likelihood estimator is a prominent example and the most-frequently used estimator. Previous literature on the performance of these estimators has primarily focussed on the role of the variance function for the estimators? behavior. We add to this literature by studying the small-sample performance of estimators in a data-generating process that is fully consistent with general equilibrium economic models of international trade. Economic theory suggests that (i) importer- and exporter-specific effects need to be accounted for in estimation, and (ii) that they are correlated with bilateral trade costs through general-equilibrium (or balance-of-payments) restrictions. We compare the performance of structural estimators, fixed effects estimators, and quasi-differences estimators in such settings, using the GLM approach as a unifying framework.